Some Issues Concerning Interest Rate Pegging, Price Level Determinacy, and the Real Bills Doctrine

In a recent paper, Canzoneri, Henderson, and Rogoff have shown that it is possible for the monetary authority to peg the nominal interest rate without creating price level indeterminacy in a simplified version of the 1975 Sargent-Wallace model. The present paper begins by reviewing that result, which involves a limiting case of a money supply rule that depicts the authority as responding to current values of the interest rate. Then it shows that there exists an alternative rule that will peg the nominal rate without creating indeterminacy, but that this rule induces a different pattern of price level fluctuations. Next the paper considers whether indeterminacy will prevail if the authority tries to effect a peg in a third way: by simply standing ready to buy and sell securities at the desired rate. Finally, the implication of the foregoing results are drawn for arguments concerning the real bills doctrine and some critical comments are directed at the recent attempted rehabilitation of that doctrine by Sargent and Wallace.

Should central banks raise their inflation targets? Some relevant issues

Several arguments are relevant. (1) In the absence of the zero lower bound (ZLB), the optimal steady-state inflation rate, according to standard reasoning, lies between deflation at the steady-state real interest rate and the Calvo-model value of zero, with calibration indicating a larger weight on the latter. (2) An attractive modification of the Calvo equation would imply that the weight on the second of these should be zero. (3) There may be some scope for monetary policy to be effective even at the ZLB. (4) Elimination of currency is feasible and would remove the ZLB constraint. (5) Increasing target inflation would undermine the rationale for central bank independence and constitute an additional movement away from intertemporal discipline.Inflation (Finance) ; Monetary policy ; Banks and banking, Central

Should Monetary Policy Respond Strongly to Output Gaps?

Much recent monetary policy analysis has featured stochastic simulations with small structural macroeconomic models that include: a spending vs. saving ( IS') sector; a price-adjustment sector; and an interest rate policy rule. The first two are frequently specified so as to reflect optimizing behavior; policy may or may not be specified as optimizing depending on the study's objectives. Some leading issues concern modifications to simple quantitative optimizing models that are needed to generate realistic degrees of persistence in inflation and output-gap variables. A major policy issue is whether it is desirable for monetary policy to respond strongly to the output gap. The paper argues that the latter is unobservable and considers the implications of using a trend-type measure while the true concept is of a type more in keeping with basic theory. In such circumstances, highly undesirable consequences are likely to ensue if policy responds strongly to the measured gap.

Price Level Determinacy with an Interest Rate Policy Rule and Rational Expectations

This paper reconsiders a result obtained by Sargent and Wallace, namely, that price level indeterminacy obtains in their well-known model if the monetary authorities adopt a policy feedback rule for the interest rate rather than the money stock. Since the Federal Reserve seems often to have used the federal funds rate as its operating instrument, with the money stack determined by the quantity demanded, this result suggests that the Sargent-Wallace model -- as well as others incorporating rational expectations -- is inconsistent with U.S. experience. It is here shown, however, that the indeterminacy result vanishes if the interest rate rule is chosen so as to have some desired effect on the expected quantity of money demanded. This revised conclusion holds even if considerable weight is given, in the choice of a rule, to the aim of smoothing interest rate fluctuations.

The case for rules in the conduct of monetary policy: a concrete example

A policy rule can be activist; the distinction between rules and discretion depends on the stage at which optimization calculations enter the policy process. Here a specific monetary rule is proposed, one that sets the monetary base each quarter in a manner designed to keep nominal aggregate demand growing smoothly at a noninflationary rate. Simulations with a simple estimated model suggest that the proposed rule would have performed well over the period 1954-85, despite financial innovations and regulatory change.Monetary policy ; Inflation (Finance) ; Monetary theory

A Linearized Version of Lucas's Neutrality Model

The model developed in Robert Lucas's influential "Expectations and the Neutrality of Money" has not been widely used for extensions or modifications of the original analysis, in part because of its difficulty of manipulation.The present paper describes a linearized version that--unlike other models prominent in the rational expectations literature--retains the original's mainfeatures yet is comparatively easy to manipulate.Two examples of modifications facilitated by this linearization are included. These involve an autoregressive money growth specification and the assumption of lump-sum (rather than proportional)monetary transfers.

A Semi-Classical Model of Price Level Adjustment

This paper investigates the theoretical and empirical properties of a model of aggregate supply behavior that was introduced in the 1970s but has received inadequate attention. The model postulates that price changes occur so as to gradually eliminate discrepancies between actual and market-clearing values and to reflect expected changes in market-clearing values. Its implications are more 'classical' than most alternative formulations that reflect gradual price adjustment. Empirical results, which utilize a proxy for market-clearing output that is a function of fixed capital and the real price of oil, are moderately encouraging but not entirely supportive.

Macroeconomics after a decade of rational expectations : some critical issues

An abstract for this article is not available.Macroeconomics

Introductory Remarks

These remarks were presented at the 2008 International Conference, gFrontiers in Monetary Theory and Policy,h held by the Institute for Monetary and Economic Studies, Bank of Japan, in Tokyo on May 28-29, 2008. I am grateful to Marvin Goodfriend for many helpful discussions.

The Optimal Inflation Rate in an Overlapping-Generations Economy with Land

This paper is concerned with the optimal inflation rate in an overlapping-generations economy in which (i) aggregate output is constrained by a standard neoclassical production function with diminishing marginal products for both capital and labor and (ii) the transaction-facilitating services of money are represented by means of a money-in-the-utility-function specification. With monetary injections provided by lump-sum transfers, the famous Chicago Rule prescription for monetary growth is necessary for Pareto optimality but a competitive equilibrium may fail to be Pareto optimal with that rule in force because of capital over accumulation. The latter possibility does not exist, however, if the economy includes an asset that is productive and non-reproducible--i.e., if the economy is one with land. As this conclusion is independent of the monetary aspects of the model, it is argued that the possibility of capital over accumulation should not be regarded as a matter of theoretical concern, even in the absence of government debt, intergenerational altruism, and social security systems or other "social contrivances."